Higgs report on non-executive directors - a summary
In April 2002 Derek Higgs was appointed by the Secretary of State for Trade and Industry to head the above review. His report, 'Review of the Role and Effectiveness of Non-Executive Directors', was published in January 2003. The Financial Reporting Council intends to issue a revised version of the Combined Code following a short period during which commentators are invited to identify any "fatal flaws" in the proposals. It is expected that the revised Combined Code will come into effect on 1 July 2003.
There are virtually no concessions for smaller listed companies. The approach is one of comply or explain any areas of non-compliance.
This article summarises the main matters and recommendations covered by the report.
- The existing Combined Code does not include a definition of the role of the board. Higgs rectifies this. The role includes:
- promoting the success of the company by directing and supervising the company's affairs;
- providing entrepreneurial leadership within prudent and effective controls where risk is assessed and managed;
- setting strategic aims and ensuring sufficient resources (financial and human) are available to meet objectives;
- reviewing management performance;
- setting corporate values and standards;
- ensuring obligations to shareholders and others are met.
- The annual report should include details of:
- how the board operates;
- performance evaluation;
- an overview of the decision making process identifying those decisions taken by the board and those delegated to management;
- the number of board and committee meetings together with the attendance record of individual directors.
- At least half the board, excluding the chairman, should be independent non-executive directors.
- There should be a strong executive representation on the board.
- There should be an appropriate mix of skills and experience.
- No-one should sit on all three main board committees (audit, remuneration and nomination).
- The role of the chairman is set out and includes:
- leading the board and ensuring its effectiveness;
- ensuring directors receive appropriate timely information;
- ensuring effective communication with shareholders;
- ensuring regular evaluation of performance (of the board as a whole, its committees and individual directors);
- ensuring non-executive directors are effective and that their relations with executive directors are constructive.
- The roles of chairman and chief executive should be separated and the division of responsibilities should be set out in writing;
- The chairman should be elected for three-year terms;
- The chief executive should not become chairman;
- At appointment the chairman should meet the independence criteria.
The non-executive directors
- The role of a non-executive is set out in an annex to the report and includes:
- challenge, and contribute to the development of, the company's strategy;
- scrutinise performance of management in meeting agreed goals and monitor reporting of performance;
- satisfy themselves on the accuracy of financial information and that financial controls/risk management are robust/defensible;
- determine executive directors' remuneration and prime role in appointing/removing senior management.
- The report details a number of personal attributes and behaviours of non-executive directors. These include:
- sound judgement and an enquiring mind;
- knowledge of the business, its operating environment and issues it faces, (Higgs emphasises that this can not be gained in the boardroom alone);
- integrity, probity and high ethical standards;
- objectivity as the basis for questioning and challenging accepted thinking of executives;
- strong interpersonal skills.
- Non-executive directors should meet at least once a year without the chairman or executive directors and the annual report should detail whether such meetings have taken place.
- Prior to appointment potential non-executive directors should carry out due diligence on the company and the board; they should ensure that they have the necessary skills, knowledge, experience and time ' an annex to the report provides guidance on this.
- Non-executive directors should ensure that they have sufficient appropriate quality information to perform their duties, where necessary they should seek further clarification.
Senior independent director
- Higgs endorses the Combined Code requirement for a senior independent director.
- This person should be available to shareholders as an alternative channel to the chairman or chief executive.
- The senior independent director should chair meetings of the non-executives.
- Higgs emphasises that non-executive directors need to be independent of mind and willing/able to challenge and question executives while maintaining a good working relationship.
- The report includes a definition of independence. The criteria include:
- not an employee within the last five years;
- no material business relationship with the company (directly or indirectly) within the last three years;
- no remuneration other than the director's fee (no involvement in share option or performance linked schemes; not a member of the pension scheme);
- no close family ties with directors, senior employees or company advisers;
- no cross directorships or significant links with other directors;
- not a representative of a significant shareholder;
- not served on the board for more than ten years.
Recruitment and appointment
- A nomination committee should be established and should be chaired by an independent non-executive director (not the chairman).
- An annex to the report contains a summary of the principal duties of a nomination committee. These include:
- before an appointment identify balance of skills, knowledge and experience required;
- identify and nominate suitable candidates given the above (looking at a wide range of backgrounds);
- annually review time commitment required for a non-executive director and consider whether non-executives are spending enough time to fulfil their duties;
- consider succession planning given challenges/opportunities facing the business;
- regularly review board structure/size/composition and recommend any necessary changes;
- give a statement of activities in the annual report including committee membership, number of meetings and attendance by members;
- make its terms of reference publicly available;
- ensure that new non-executive directors receive a formal letter of appointment setting out expectations (a specimen letter is included as an annex to the report).
- The nomination committee should have a majority of independent non-executive directors.
- Executive development programmes should be considered to train suitable individuals for future roles as directors.
- When shareholder approval is sought for the appointment of a non-executive director the board should set out the reasons why that person is appropriate and how they meet the requirements of the role.
Induction and professional development
- There should be a comprehensive induction programme for new non-executive directors (an annex to the report provides an induction checklist).
- The chairman should address the developmental needs of the whole board to enhance effectiveness; adequate resources should be made available to develop/refresh the skills/knowledge of directors.
- Performance of the board should be evaluated annually and the annual report should indicate whether, and how, this is done (the report includes an annex providing guidance on performance evaluation).
- Higgs suggests that non-executive directors should conduct self-appraisals of their skills, knowledge and expertise.
Tenure and time commitment
- Normal tenure of non-executive directors to be two three-year terms; explanation should be given to shareholders for any longer terms.
- If tenure is more than nine years annual re-election of the director is required.
- If offered an appointment elsewhere non-executives should inform the chairman before accepting.
- Full-time executive directors should hold only one non-executive position in, and should not become chairman of, a major company (being a company in the FTSE 100).
- No-one should chair more than one major company board.
- Non-executive directors should provide the chairman with their reasons for resigning, especially when they do so because of concerns over either the way the company is run or a proposed course of action.
- Remuneration should reflect the workload, complexity and responsibility involved.
- Part may be taken in the form of shares.
- Non-executives should not normally hold share options; where they do advance shareholder approval should be obtained and the shares so acquired should be held for a year after the individual leaves the board.
- At least three members; all members to be independent non-executive directors.
- Terms of reference should be published and principal duties (as set out in an annex to the report) should include:
- determine remuneration framework and policy;
- set remuneration (including bonuses, incentives and share options) of executive directors, chairman and company secretary;
- determine targets for performance related pay schemes;
- determine policy on pension arrangements for executive directors;
- ensure contractual terms are reasonable and that failure is not rewarded;
- advise on changes to employee benefit structures;
- agree policy for authorising expense claims from chairman and chief executive;
- ensure the annual report contains all the necessary disclosures.
- The report recognises that the question of liability is an important one and suggests a number of areas the Government should address.
- Appropriate directors' and officers' insurance should be provided by companies.
Relationships with shareholders
- All non-executive directors, especially those chairing board committees, should attend the AGM.
- The senior independent director should attend certain meetings with major shareholders.
- As part of the induction process non-executive directors should meet major investors.
- The annual report should state what steps have been taken to ensure that the board (and non-executives in particular) has an understanding of the views of major investors.
Smaller listed companies
- A smaller company is defined as one outside the FTSE 350.
- Higgs recognises that the 'one size fits all' approach may not be appropriate but concludes that all public companies have certain obligations and therefore does not allow for any differentiation.
- The report acknowledges that it may take smaller companies more time to comply and that some provisions will be less relevant/manageable.
- The only exception is the restriction that no-one should be on all three main board committees ' this does not apply to smaller companies.
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